News flash: Almost every investment has costs or fees.
You probably already knew that, but if you’re like most people, that’s the extent of your knowledge on the subject. I meet people every day that have investments, yet almost nobody knows or understands the kind of fees they have with those investments.
It’s kind of like going through life with a debit card and every time you need something, you just swipe it. Of course, you know that whatever you’re buying costs money, but if you don’t read or understand the receipt, it’s never a problem until you have no more money. With a debit card you really don’t need to know what things cost until your card is declined; up until that point the money just magically leaves your checking account.
So how is this the same as an investment? Let’s start with a basic mutual fund; there are many annual costs associated with the ownership of mutual funds. The six most common costs are:
1. Fees paid to the fund’s investment managers. (Most people know this fee exists, yet have no idea how much it is.)
2. 12b-1 fees paid to the fund company to cover advertising and marketing expenses. (Bet you didn’t know you had to pay for that also.)
3. Up-front or deferred sales charges paid to those who sell the mutual fund. (This is sometimes the only fee people are aware of.)
4. Trading costs incurred by the mutual fund company for buying and selling stock.
5. Annual income taxes.
6. Miscellaneous costs.
One of the problems with determining mutual fund costs is the fact that many of these costs are taken out of the mutual fund’s gain each year by the mutual fund company. The only two expenses that a mutual fund owner will actually pay out of his or her pocket are up-front A-Share mutual fund commissions and annual income taxes owned on the mutual fund. Even this last cost is not actually paid separately, but is included in the total tax liability paid by the fund owner annually to the IRS on all of his or her income.
When you consider all of the factors in determining the total cost of owning the average, actively, managed, and taxable equity mutual fund, it is conservatively in the range of 5.25 percent!
• Here is a hypothetical example:
• Annual expense and 12b-1 fees: 1.55 percent
• Commissions/fees (5 percent annualized for five years): 1.00 percent
• Administrative and misc. costs: 0.15 percent
• Trading costs: 0.70 percent
• Owner’s annual net income tax liability: 1.43 percent
Total of these would be 4.83 percent.
That means that with a $100,000 investment; $4,830 might go missing from your bottom line.
Now multiply that by the 10 years or so you expect to have this hypothetical mutual fund and you might be missing around $48,300 dollars.
The most common thought I have when I evaluate people’s mutual fund holdings is; you don’t know what you don’t know. There are many different ways to invest wisely and they all start with good knowledge and a good understanding of your investment. There are a number of ways to invest wisely and perhaps dramatically lower your costs, but you have to be working with someone that can give you an unbiased evaluation. If you’re not working with someone who can do this, maybe it’s time to get an unbiased knowledgeable second opinion.